IRS Return Selection:

Improved Planning, Internal Controls, and Data Would Enhance Large Business Division Efforts to Implement New Compliance Approach

GAO-17-324: Published: Mar 28, 2017. Publicly Released: Apr 27, 2017.

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James R. McTigue Jr.
(202) 512-9110
mctiguej@gao.gov

 

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The IRS's Large Business and International division audits large partnerships and corporations (worth at least $10 million) and wealthy individuals—which sometimes poses compliance challenges. For example, the underreported income tax of corporations alone was about $28 million annually between 2008 and 2010.

This division is implementing a new approach to compliance that focuses on specific issues, such as partnerships that underreport certain types of income. We found that the IRS has made progress in implementing this approach but recommended that it fully address all the project planning principles necessary to effectively implement it.

Conceptual Overview of How the Large Business and International Division Selects Tax Returns for Audit

A funnel graphic show five levels, starting at returns filed and ending at audit selection.

A funnel graphic show five levels, starting at returns filed and ending at audit selection.

Additional Materials:

Contact:

James R. McTigue Jr.
(202) 512-9110
mctiguej@gao.gov

 

Office of Public Affairs
(202) 512-4800
youngc1@gao.gov

What GAO Found

The Internal Revenue Service's (IRS) Large Business and International division (LB&I) uses a variety of methods, such as computer models and staff reviews of returns, to identify tax returns for audit consideration. From the returns identified, managers and auditors in LB&I field offices select the returns to be audited. For the eight methods LB&I uses for identifying and selecting tax returns for audit (selection methods) that GAO analyzed, LB&I documentation on its procedures and policies generally reflected 4 of the 10 internal control principles GAO reviewed. For example:

  • Related to the internal control principle of demonstrating commitment to integrity and ethical values, LB&I auditors who identify tax returns for audit consideration are prohibited from auditing those returns themselves or assigning them to specific individuals for audit. In addition, all LB&I staff completed a required training on ethics and impartiality in 2015, the latest available data.
  • Related to the internal control principle of demonstrating a commitment to competence, LB&I's procedures and manuals generally documented its training to help assure the competence of staff involved in audit selection. This training included courses on basic skills as well as instruction on more specific topics.

However, for the other 6 internal control principles GAO reviewed, there were gaps in documentation that limit LB&I's assurance that its selection methods are being implemented as designed and are supporting its objectives. For example:

  • Related to the internal control principle of identifying, analyzing, and responding to risk, LB&I documentation did not specify procedures or a process for how to respond to changing circumstances, such as a change in the law, in selecting returns for audit.
  • Related to the internal control principle of reporting on issues and remediating related deficiencies, LB&I documentation indicated that problems identified with selection methods were discussed in meetings, but not that corrective action was taken to address them.

GAO also found that LB&I has monitoring directives, but it does not have a standard process for monitoring field staff's audit selection decisions. Without such a process, LB&I lacks reasonable assurance that decisions are made consistently.

LB&I is in the process of implementing a new approach for addressing taxpayer compliance, including how it identifies tax returns for audit. LB&I plans to implement what officials call “campaigns,” which are projects focused on a specific compliance-related issue, such as partnerships underreporting certain income, rather than projects focused on the characteristics of whole tax returns. According to LB&I officials, campaigns could include conducting audits as well as other efforts, such as reaching out to taxpayers and tax professionals, issuing guidance, and participating in industry events. LB&I officials said certain audit selection methods that existed prior to the development of campaigns will operate while LB&I implements its campaign approach, and campaigns may subsume some of those methods.

GAO found that LB&I made some progress in implementing its new compliance approach, such as by involving stakeholders in plans and implementing the process for submitting proposals for campaigns. However, LB&I has not fully met five project planning principles set forth in prior GAO work (see table below). Until it fully meets these principles, LB&I management lacks reasonable assurance that its new compliance approach will succeed in accomplishing its overall objectives of encouraging voluntary compliance and fair treatment of taxpayers.

Large Business and International (LB&I) Division's Plans for New Compliance Approach Assessed against Project Planning Principles as of December 2016

Highlights_v5_100529_324

Why GAO Did This Study

LB&I audits large partnerships and corporations with $10 million or more in assets and high wealth individuals. These entities pose compliance challenges. For example, IRS reported that the gross underreported income tax of large corporations alone averaged an estimated $28 billion annually between 2008 and 2010, the most recent data. It is important for LB&I to have adequate controls for its audit procedures and to properly plan and implement its new approach to address noncompliance.

GAO was asked to evaluate how IRS selects returns and is implementing its new compliance approach. Among other objectives, this report (1) assesses the extent that LB&I's documented procedures and policies for its audit selection methods generally reflected relevant internal control principles, (2) assesses the extent that LB&I has a standard process to monitor audit selection decisions, and (3) assesses the extent that LB&I has planned and implemented its new approach to address compliance.

GAO reviewed LB&I procedures and policies for eight selection methods that involved the use of discretion and its plans for implementing a new compliance approach. Given the status of LB&I's plans for and implementation of its new approach, GAO did not assess LB&I's decision to create the approach. GAO held focus groups with LB&I staff responsible for selecting audits, and interviewed IRS official

What GAO Recommends

GAO recommends that IRS address documentation gaps in its selection method procedures and policies related to six internal control principles, develop a standard process to monitor field staff's audit selection decisions, and take seven actions to fully address planning principles in its efforts to implement its new compliance approach. In commenting a draft of this report, IRS agreed with all of the recommendations.

For more information, contact James R. McTigue Jr. at (202) 512-9110 or mctiguej@gao.gov.

Recommendations for Executive Action

  1. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including defining objectives to identify risk and defining risk tolerances.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  2. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including identifying, analyzing, and responding to risks to achieving the objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  3. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including designing control activities to achieve objectives and responding to risks.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  4. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including using quality information to achieve objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  5. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including communicating internally the necessary quality information about the objectives.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  6. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: As LB&I finishes implementing its new approach and decides which selection methods will be used with the campaigns, the Commissioner of Internal Revenue should ensure that the documentation gaps in policies and procedures are addressed for six internal control principles for the selection methods that will be used, including evaluating issues and remediating identified internal control deficiencies on a timely basis.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  7. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: Also in accordance with federal internal control standards, the Commissioner should direct LB&I to adopt a standard process for monitoring audit selection decisions in the field, such as by modifying the existing quality control system.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  8. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should create a timetable with specific dates for implementing its new compliance approach.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  9. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should establish metrics to help determine whether the campaign effort overall meets LB&I's goals.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  10. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should finalize and document plans to evaluate the human resources expended on campaign activities.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  11. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should document lessons learned from stakeholder input and past performance.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  12. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should monitor overall performance across future campaigns, not just individual compliance projects, and in doing so ensure that the data used for monitoring accounts for the costs beyond the auditor's time can clearly be linked with specific selection methods, including the Discriminant Analysis System method, to the extent that the selection methods continue to operate.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  13. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should develop and document criteria to use in choosing selection methods for campaigns using audits.

    Agency Affected: Department of the Treasury: Internal Revenue Service

  14. Status: Open

    Comments: When we confirm what actions the agency has taken in response to this recommendation, we will provide updated information.

    Recommendation: To further ensure that the new campaigns under LB&I's new approach for addressing tax compliance are implemented successfully, the Commissioner should set a timetable to analyze and mitigate risks and document specific metrics for assessing mitigation of identified risks.

    Agency Affected: Department of the Treasury: Internal Revenue Service

 

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